"Phenomenally accurate forecasts"

We have no more confidence that the Fed chairman will get us out of this mess than we did in his predecessor's ability to stop it from happening. Ben Bernanke is supposedly a student of the Great Depression, and so we might have expected him to change tactics long ago -- from battling inflation to warding off the far more serious threat of a ruinous debt deflation. Instead, for the last two years, the Fed continued to act, by not acting, as though a niggling rise in the price of eggs, gasoline, and shoe laces were somehow more threatening than the by-now unstoppable deterioration of the real estate market.

Unfortunately, now that the Fed has made it implicit that it will do whatever it takes to keep the financial system liquid, it appears doubtful that any rescue attempt can succeed. The central bank will be pushing on a string, as the saying goes, unable to trigger yet one more borrowing binge by consumers who have become hopelessly trapped in the worst real estate slump since the Great Depression. Moreover, we doubt the Fed even knows what it is doing as it plays whack-a-mole with each new financial crisis that springs up.

Preparing for a Typhoon

A dissenting view is that the Fed not only knows what it is doing, but that it is taking uncharacteristic pains to prepare America for an economic typhoon. That is the substance of a letter we received recently from Erich Simon, our friend and erstwhile bird flu expert. Here is Erich's take on the post-Greenspan Fed in crisis:

"Bernanke isn't buoying the markets like his predecessor did with under-the-table deals. He is making provision for write-offs, marks-to-market -- for all the wantonly speculative behavior of an overcrowded planet with little gainful employment. It used to be Government Projects, road building and such; now it is home-building and new additions, meaningless contribution. Bernanke is preparing the world for the pain of reality.

"How is the Fed chairman, the very pillar of mediocrity, going to prepare 'us' for a future that mediocrity can't even imagine? First, a few thoughts. There's the China Wild Card, for one. China is going to take Taiwan at some point. Olympics notwithstanding, I had put 2008 as the year that Red patience would finally run out. The Chinese are on schedule to take possession of a small fleet of nuclear-equipped submarines. And they have been telegraphing -- indeed the larger Asian cabal going back to 1997 when Vietnam moved all of its reserves into gold, off the radar of our even more mediocre Congress -- the Chinese have been telegraphing a move out of U.S. reserves.

A Telling Stutter

"Second, Bernanke navigates interrogation not so well as Greenspan but better than many seem to think. He shows his cards when he stutters, though, and he does stutter when he is navigating around issues that are an indictment of the abyss.

"Bernanke understands all too well what is at stake here. The darkest recess of the abyss, and a carryover from the previous administration, is the trade deficit. Greenspan once acknowledged that the deficit was untenable but that no one knew when it would reconcile. Bernanke is caught. He knows that it is going to reconcile. The only question is how. Without going into a history of trade deficits, the present situation is a historical stretch of anything that has ever occurred. According to Bernanke, the deficit will not be resolved in the currency markets, but rather in the 'structure' of global manufacturing. That is, by a return to domestic production and an epic 'reset' of the U.S. business cycle.

"Now to the question. Bernanke is not going to throw Wall Street a bone. He is not going to lower interest rates (and if he does, he risks an exploding gold price and an out-of-control, knee-jerk run on the dollar -- nothing short of a classic Rollover, the marking-to- market of the Value of All Things paper!) . He will 'print' domestic dollars to grease the mechanism of the system, understanding only too well that the U.S. has a savings deficit and you don't encourage savings with inflation. He will jawbone. He will handhold. He will grant favors."

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